Business context and reporting period
Carpenter Technology Corporation filed this unaudited Form 10-Q for the fiscal quarter and six months ended December 31, 2012 (the second quarter of fiscal 2013). The company manufactures, fabricates, and distributes specialty metals and related products. Results include Latrobe Specialty Metals, acquired on February 29, 2012; Latrobe contributed $95.2 million of quarterly sales and $209.8 million of six-month sales.
Key financial results
Dollar amounts are in millions, except per-share data. Comparisons are with the corresponding prior-year period.
| Metric | Quarter | Six months |
|---|---|---|
| Net sales | $533.5; up 24% | $1,078.5; up 28% |
| Sales excluding raw-material surcharges | $430.7; up 30% | $871.5; up 35% |
| Gross profit / margin | $102.6 / 19.2%; prior year $84.3 / 19.6% | $212.0 / 19.7%; prior year $165.5 / 19.6% |
| Operating income | $52.7; prior year $43.9 | $114.3; prior year $87.9 |
| Net income attributable to Carpenter | $33.0; prior year $23.6 | $72.2; prior year $47.4 |
| Diluted EPS | $0.62; prior year $0.52 | $1.35; prior year $1.05 |
| Operating cash flow | $2.2, versus cash used of $27.8 in the prior-year six-month period |
Gross margin excluding surcharges was 23.8% for the quarter versus 25.5% a year earlier, and 24.3% for six months versus 25.7%. Management attributed higher gross profit dollars principally to Latrobe, volume, and product mix, while lower production levels and manufacturing costs weighed on results. Reported operating-margin measures excluding surcharges and certain pension and acquisition items were 14.1% for the quarter (15.1% prior year) and 15.0% for six months (15.4% prior year); these are non-GAAP measures.
Cash, debt, and liquidity
Cash was $63.1 million at December 31, 2012, down from $211.0 million at June 30, 2012. Six-month capital spending was $136.9 million, pension contributions were $57.9 million, and free cash flow, as defined by the company, was negative $154.2 million (negative $105.5 million a year earlier). Inventory rose to $733.6 million from $642.0 million at fiscal year-end.
Total debt, including current maturities, was $406.2 million. The $101.0 million current portion matures in May 2013. The company had $342.8 million available on its $350.0 million revolving facility and reported total liquidity of approximately $406 million. It was in compliance with its credit covenants; actual interest coverage was 19.66 to 1.0 against a 3.5 minimum, and debt to capital was 26% against a 55% maximum.
Material changes and management commentary
- Latrobe materially increased reported sales and shipments. Excluding Latrobe, quarterly sales excluding surcharges rose 5% on 2% higher volume; six-month sales excluding surcharges rose 7% on 3% higher volume.
- On a pro forma basis assuming Latrobe had been owned from July 1, 2011, quarterly revenue was $533.5 million versus $531.7 million, while earnings were $33.0 million versus $40.8 million. Six-month pro forma revenue was $1,078.5 million versus $1,074.0 million, and earnings were $72.2 million versus $64.3 million. These unaudited figures are not necessarily indicative of results that would have occurred.
- Aerospace and defense and energy demand were strong. Medical sales weakened amid titanium distribution-channel destocking and softer near-term demand; powder metals faced continued weakness in Europe and lower-value products. The company said Latrobe was performing ahead of deal economics and synergies were progressing ahead of plan.
- The company began a process to sell the Latrobe and Mexico distribution businesses, but they did not qualify as held for sale or discontinued operations at quarter-end. It intends to reinvest any proceeds in more strategic businesses.
- The Sandvik strategic partnership was dissolved in November 2012. Carpenter received $7.9 million for its investment and paid $8.4 million to acquire the remaining interest in Carpenter Powder Products AB; a $1.9 million gain was recorded on the investment sale.
Outlook, initiatives, and risks
- Management expected fiscal 2013 capital expenditures of approximately $350 million. The Alabama premium-products facility is a roughly $500 million project, expected to add capacity of about 27,000 tons annually and become operational by April 2014.
- Management expected fiscal 2013 net pension expense of $68.3 million, compared with $42.1 million in fiscal 2012. It expected approximately $24 million of additional required pension contributions in the remainder of fiscal 2013 and estimated minimum required contributions of approximately $400 million over five years, subject to market and interest-rate assumptions.
- The company said it might refinance debt in the second half of fiscal 2013, potentially combining a discretionary pension contribution of up to approximately $165 million with refinancing the $101 million May 2013 maturity. This was conditional on market conditions, not a commitment.
- Facility start-up, footprint optimization, and inventory-reduction initiatives reduced operating income by $2.5 million in the quarter and $4.1 million in six months. Management estimated fiscal 2013 costs of approximately $6 million, $3 million, and $3 million, respectively, and expected inventory-efficiency benefits in the second half of fiscal 2013.
- The American Taxpayer Relief Act was expected to provide an approximately $2 million tax benefit in fiscal 2013’s third quarter.
- Risks include cyclical end markets, raw-material price and surcharge timing, pension funding and expense volatility, acquisition integration and valuation, and production concentration in specialized equipment. Approximately 70% of $38.1 million in deferred commodity-contract losses related to contracts supporting firm-price sales to one customer, in addition to trade receivables exposure to that customer.
- Recorded environmental remediation liabilities were $4.9 million. A potential Department of Commerce civil penalty relating to historical export-control disclosures remained unquantified, and no liability was recorded. Management stated routine litigation was not expected to have a material long-term effect, while noting outcomes could affect an individual period.
Important facts for investors to verify
- How much of reported growth and earnings improvement is attributable to Latrobe, and how do ongoing results compare with the pro forma prior-year figures?
- Whether planned capital spending, the Alabama facility, and inventory-reduction actions deliver expected capacity and cash-flow benefits.
- Whether pension contributions and the May 2013 debt maturity are funded or refinanced as contemplated, and whether liquidity remains adequate.
- The exposure represented by the customer concentration in deferred commodity hedge losses and related receivables.
- Progress on the proposed Latrobe and Mexico distribution business sales, the final Latrobe purchase-price allocation, and unresolved export-control and other contingencies.